But this time, there is more than 8% inflation.
By Wolf Richter for WOLF STREET.
The Dow Jones Industrial Average closed Friday about 300 points below its June 16 low, more than wiping out gains from the bear market rally. For the Dow, the bear market rally began on June 17 and ended on August 16. During the two-month rally, the Dow had jumped 14%. On Friday at the close, it was again down 20% from its all-time high.
The S&P 500 index intraday Friday fell to its June 16 closing low – the infamous 3,666 – then rebounded slightly to close 27 points above the June 16 low of 3,693. During the two-month bear market rally through August 16, the index jumped 17%. On Friday, the index was down 23% from its all-time high.
The Nasdaq closed about 2% above its June low. During the two-month rally, it had climbed 23%. Many of my imploded stocks that are now trading for a few dollars soared 50% or more, and a bunch of them doubled, before re-imploding after mid-August.
The bond market – and with it the mortgage market – had a huge bearish rally, but people there came to their senses two weeks earlier, on August 1.
The 10-year Treasury yield had climbed to 3.48% on June 14 (rising yields mean lower bond prices; falling yields mean higher bond prices). As of August 1, the 10-year yield had fallen to 2.57%, and it had been a huge rally.
In the mortgage market, there was an even more stunning bear rally: the average 30-year fixed mortgage rate had hit a 14-year high of 6.28% on June 14, according to Mortgage News Daily’s daily gauge. The average rate then fell 1.23 percentage points to a low of 5.05% on August 1. Real estate agents were already talking about an improvement in home sales. On Friday, according to this daily measure, the average 30-year fixed mortgage rate reached 6.70%.
The bear market rally came just as the Fed had already embarked on the most aggressive tightening cycle in decades and started quantitative tightening, which means shedding Treasuries and asset-backed securities. to mortgages.
The Fed-pivot fantasy did.
The bear market rally happened because the markets – meaning the people and algos who play in them – had this fabulous reaction to the aggressive Fed rate hike scenario: they started to fantasize about a Fed “pivot” and rate cuts and some even QE everywhere. Again. Asset prices started to jump and yields started to fall.
Many of us, in our illustrious Wolf Street commentaries, expected a rally. And I drew parallels with the bear market rally during the dotcom crash. During this two-month rally, from mid-May to mid-July 2000, the Nasdaq jumped 33% without ever returning to its former high. In the end, the Nasdaq crashed 78%.
That two-month bear rally in the summer of 2000 brought a lot of people back into the market, thinking stocks were going to the moon again, and they were crushed.
The 2022 bear market rally started in mid-June and also lasted two months. It came as the Fed’s kingpin fantasy mongers – including some well-known hedge fund managers – fanned out across financial media, social media and the rest of the internet, saying the Fed would soon pivot, that in fact he wasn’t even doing QT after all, and yada-yada-yada.
So we had a huge two-month rally, and Fed pivot dealers, including hedge funds, that got out in time made a huge amount of money. But those people who believed in the pivot fantasy and bought when the pivot sellers sold, well, those people took the losses. But that’s always how it goes.
The dotcom-bust parallel forms.
It was easy to see what they were up to, and it became a hot topic in Wolf Street commentary. On July 19, for example, I said this in a comment:
Over the last 8 trading days, the S&P 500 finished 2 days higher (including today) and 6 days lower. We have to organize a summer rally, but so far it’s been a pretty shitty summer rally.
In the summer of 2000, from May 27 to July 17, the Nasdaq rebounded 33%, amid what was ultimately a 78% crash. It was a summer rally in a bear market! But it is far from having reached a new peak in the summer of 2000. Far from it. The high was 5,000 in March 2000. On July 17, 2000, it fell back to 4,275.
The Nasdaq didn’t reach a new high until July 2015, 15 years later, and it took trillions of dollars of Fed money printing to get there. Now the printing of money has stopped and the Fed is doing QT. And CPI inflation is 9%, and the wage-price spiral has started, and there’s a chance the Nasdaq will take a very long time to get back to 16,200.
I repeated the dotcom-bust parallel because it just keeps getting more parallel, so to speak.
The bear market rally has continued, to the point that on July 31 I warned in a very poopy podcast that the markets are fighting the Fed, and that fighting the Fed would only make the Fed more aggressive in pushing through its message to the markets because it relied on the markets to transmit its monetary policies through financial conditions to the real economy and demand – the markets are its “transmission channel” – and that the Fed would ultimately win this fight.
The podcast received 317 comments on Wolf Street. The podcast transcript, posted Aug. 3, received 259 more comments. It was a hotly debated topic.
The simple fact is this: a bubble of everything inflated by the Fed.
Since 2008, the Fed has inflated asset prices with interest rate repression and QE, huge amounts of QE. This caused the biggest asset bubble of all time – the bubble of everything.
QE was designed to enrich asset holders to spend a little more and thus let some droplets of their newly acquired wealth flow. In 2010, then-Fed Chairman Ben Bernanke, in an op-ed in the Washington Post, explained this “wealth effect” theory to the astonished American people.
The Fed got away with it because it didn’t trigger a lot of consumer price inflation because consumers didn’t get that money; this triggered huge asset price inflation because asset holders got that money, and with their earnings from those assets, they ran after the assets with that money, instead of spending it, and it doesn’t So there weren’t a lot of fallouts.
But in late 2017, as Yellen prepared to hand over to Powell, who had been appointed Fed Chairman by Trump, the Fed began phasing in quantitative tightening. At first the increments were so small they were hard to see. Then QT got bigger.
At the beginning of October 2018, the markets began to collapse. In November, mortgage rates hit 5% and the housing market began to falter. At Christmas 2018, the S&P 500 index was down 20%. Even that small, slow, incremental QT and small 25 basis point rate hikes – just four of them in 2018, just 2.5% at the upper end of the target range – had a big effect in these artificially inflated markets. .
But there is a huge difference between yesterday and today: inflation.
In 2018, inflation was at or below the Fed’s target, and the Fed was just trying to “normalize” its policy, and it was just trying to bring its balance sheet down to a manageable level. He just wanted to go back to some kind of “neutral”. Nonetheless, Powell came under blistering pressure from Trump, who had taken ownership of the Dow Jones. And with inflation below the Fed’s target, and with the Dow Jones plummeting, and with Trump toppling Powell daily, the Fed made its infamous pivot, and markets soared again.
The lesson was this: these artificially inflated markets can’t even sustain their level amid rate hikes and QT. Even small rate hikes, only four in a year, and small amounts of QT sent markets tumbling much like the interest rate crackdown and QE had sent them soaring. It became clear to everyone: QT had the opposite effect of QE.
But in 2022 inflation soared above 8%, its highest level in 40 years, and spread across the economy and is now peaking in services, away from the chains of services. supplies and raw materials, even as the inflation of certain goods has begun to subside. And there won’t be a Fed pivot until that inflation makes “compelling” progress, as the Fed calls it, back to 2%, which could be a long way off.
QT until something breaks? Wait a minute…
There have been many people who have said that the Fed will continue to do QT “until something breaks”. Last time it did QT until the repo market broke. That’s when banks stopped lending to the repo market, which then exploded, prompting the Fed to bail it out in September 2019.
But this time, the most important thing the Fed is responsible for has already broken: price stability. Inflation is the worst in 40 years. And the Fed is tightening up its efforts to fix this huge glitch that got shattered – to get that inflation under control and down to 2% (based on the core PCE). It could be a long and difficult job. And other things that could break along the way are in comparison only minor inconveniences.
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